The Financial Markets Authority (FMA) of New Zealand is seeking feedback on potential changes to the standard conditions imposed on Derivative Issuer (DI) licences. The changes relate to leverage and the suitability of investors for derivative trading.

The proposed changes have been identified in the FMA’s 2020 Derivatives Issuer Sector Risk Assessment (SRA) and subsequent monitoring of the sector.

• Proposed leverage standard condition

Investing with leverage amplifies the risk by enabling an investor to have much greater exposure to an increase and decrease in value. Currently, there is no limit to the amount of leverage a licensed DI can offer to retail investors in New Zealand. For example, while some licensed DIs limit contracts for difference (CFDs) leverage to 30:1, others offer up to 500:1.

Under the proposal:

“Standard Condition:

1. You must not offer or issue an over-the-counter derivative to a retail investor unless the terms of the derivative require the retail investor to provide an initial margin of at least:

(a) 3.33% of the value of the total exposure derived from the transaction if the underlying for the derivative is an exchange rate for a major currency pair; and

(b) 5% of the value of the total exposure derived from the transaction if the underlying for the derivative is an exchange rate for a minor currency pair, a major stock market index or gold; and

(c) 10% of the value of the total exposure derived from the transaction if the underlying for the derivative is a minor stock market index or a commodity other than gold; and

(d) 50% of the value of the total exposure derived from the transaction if the underlying for the derivative is a cryptoasset (including cryptocurrency); and

(e) 20% of the value of the total exposure derived from the transaction if the underlying for the derivative is an equity security or an asset not otherwise listed in 1(a) to (d)”.

The proposed standard condition is similar to those in the UK, Europe and Australia and varies depending on the underlying asset class of the derivative.

• Changes to suitability standard condition

The SRA and subsequent monitoring indicated some licensed DIs were not always taking sufficient steps to determine suitability for the investor. Monitoring also found that some of the suitability assessments were poorly designed or ineffective.

Licensed DIs offer a wide range of derivatives with varying degrees of risk. While some are straightforward, others, like binary options or cryptocurrency CFDs, can be opaque or volatile and are therefore riskier.

The FMA considers it both appropriate and necessary to revise the suitability standard condition to ensure that DIs ask retail investors for relevant information needed to assess whether the derivative is suitable.

The FMA has revised the suitability condition to require that DIs must determine whether the retail investor understands the derivative before investing.

The consultation period runs until 7 August.